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'Wall of Worry' Rebuilt

Investors withdrawing money from U.S. stocks and holding cash, as some industries lose the most market cap since 2008.

Investors are losing their nerve in the stock market amid selling that has sent some industries down the most since 2008. In the past, that’s been a signal to buy.

Global money managers raised cash holdings to a two-year high this month and say America is the worst place to invest, a Bank of America Corp. survey published last week shows. Investors have pulled about $10 billion from funds that buy U.S. equity this month, set for the biggest outflows since August, according to data compiled by Bloomberg and the Investment Company Institute.

After embracing stocks last year for the first time since the bull market began, individuals are showing signs of reverting to the skepticism that led them to pull more than $400 billion from mutual funds from 2009 through 2012. While hedge fund manager David Tepper says caution is appropriate now, others consider the lack of exuberance a healthy sign that sets the stage for more gains.

“Walls of worry are everywhere,” Robert Doll, who helps oversee $118 billion as chief equity strategist at Nuveen Asset Management in Chicago, told Tom Keene and Michael McKee on Bloomberg Radio’s “Surveillance” on May 14. “This is the least-believed bull market that I’ve ever seen. From here it’s earnings, it’s fundamentals, it’s can the economy grow? And my guess is the answer to that question is yes.”

Since 2000, there had been 12 instances when money flows to equity funds turned negative following at least three months of deposits. On average, the S&P 500 was 2.2 percent higher 60 days later, compared with a mean increase of 0.6 percent for all comparable periods, according to data compiled by Bloomberg.

The S&P 500 was little changed last week after reaching an all-time high of 1,897.45 on May 13. Since early March, the Russell 2000 Index of smaller shares has fallen 8.8 percent and the Nasdaq Internet Index is down 18 percent as investors exited stocks with the highest valuations.

The S&P 500 added 0.1 percent to 1,879.91 at 9:50 a.m. in New York today.

The Internet gauge has slipped 1.2 percent in May, poised for a third month of declines, the longest stretch since 2008. About one-fifth of Nasdaq-listed shares, including Seattle-based Amazon.com Inc. and Whole Foods Market Inc. in Austin, Texas, dropped more than 20 percent this year.

“People are a little bit concerned that something could be on the horizon,” Eric Schoenstein, co-manager of the $5.3 billion Jensen Quality Growth Fund in Portland, Oregon, said by phone on May 15, referring to a potential market crash similar to those that began in 2000 and 2007. “Investors are skittish, and that probably makes sense because it lengthens the bull market.”

Holding Cash

Tepper, founder of $20 billion hedge-fund firm Appaloosa Management LP, urged investors last week to hold some cash and focus on avoiding losses rather than making profits. The U.S. economy isn’t expanding at a sufficient pace, and financial markets are “dangerous,” he said at the SkyBridge Alternatives Conference in Las Vegas on May 14.

The concern was echoed by Bank of America’s survey of 218 global money managers, who cut U.S. equities in the past month and boosted cash holdings to the highest level since June 2012. Funds held an average 5 percent in cash, according to the survey, which was conducted during the week through May 8.

“When you see this type of downdraft in very visible names, people’s risk-averse attitude tends to take over,” Margie Patel, who oversees about $1.4 billion at Wells Capital Management in Boston, said by phone on May 15. “After the economic crisis, a lot of investors were traumatized. People are more looking at preserving their assets.”

The proportion of respondents citing the U.S. as the least-attractive destination for investments doubled to 18 percent in May from a month ago, Bank of America’s survey found.

Investors prefer Europe, saying their stocks are undervalued, according to the survey. The S&P 500 is trading at 16 times estimated profits, compared with the multiple of 15 for the Stoxx Europe 600 Index, data compiled by Bloomberg show.

Besides lower valuations, European stocks get more support from the central bank, according to Hayes Miller, the Boston-based head of multi-asset allocation in North America at Baring Asset Management Inc. While the Federal Reserve has cut its economic stimulus for a third time in a row this year, the European Central Bank may increase monetary easing, he said.

The ECB “is likely to be looser for longer, and that’s going to help drive earnings growth profiles to positive surprises going forward,” Miller said by phone on May 15. His firm oversees about $57 billion and favors Europe over the U.S. “We don’t have much to go on” in the U.S., he said.

Equity ETFs

Investors pulled $7.7 billion out of U.S. equity ETFs in the first half of May, data compiled by Bloomberg show. They withdrew almost $2 billion from mutual funds during the week through May 7, according to an estimate by ICI. In the previous three months, deposits totaled $35 billion.

Reversals like this preceded stock gains nine out of the 12 times since 2000, data compiled by Bloomberg show. The last time fund flows turned negative in January, the S&P 500 advanced 5 percent over the next two months.

Individuals weren’t convinced that stocks are safe to buy until the S&P 500 more than doubled from its 2009 low. They added more than $150 billion to equities in 2013, after withdrawing $260 billion in the previous four years, data compiled by ICI and Bloomberg show. With their return, the S&P 500 jumped 30 percent, the most since 1997.

Today’s bearish investors are tomorrow’s bulls, according to Chris Bouffard, chief investment officer at the Mutual Fund Store in Overland Park, Kansas. Sentiment will improve once the economy rebounds from a weather-related slowdown, he said.

U.S. gross domestic product grew 0.1 percent in the first quarter, for the lowest pace in a year, as severe winter weather hurt housing to retail sales. The economy will expand 2.5 percent this year and accelerate to 3.1 percent in 2015, according to the median of 94 economists’ estimates in a Bloomberg survey.

“There is a solid foundation for an advancing market,” Bouffard said by phone on May 15. His firm oversees $9 billion. “We certainly see that cautious stance among pockets of our clients. It’s not because there is any impending sense of doom. It’s people taking money off the table and playing defensive. There is some inherent buying power.”

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